Earnings per Share

Definition

Earnings per Share (EPS) is a financial metric that indicates the profitability of a company on a per-share basis. It is calculated by dividing the net income of a company by the number of outstanding shares of its common stock. EPS serves as a key indicator for investors to assess a company's financial health and performance, often influencing stock prices and investment decisions.

5 Must Know Facts For Your Next Test

1. EPS can be reported as basic or diluted; basic EPS uses the number of outstanding shares, while diluted EPS accounts for potential shares from options or convertible securities.
2. A higher EPS indicates greater profitability, making it more attractive to investors and often leading to an increase in stock price.
3. Companies may use EPS as a target for performance-based compensation, aligning management's interests with those of shareholders.
4. Earnings per share is often used in conjunction with other metrics like revenue growth and profit margins to provide a fuller picture of financial performance.
5. Changes in EPS can significantly affect market perceptions and investor sentiment, impacting stock prices dramatically after earnings announcements.

Review Questions

• How does the calculation of Earnings per Share differ between basic and diluted EPS?
  • Basic Earnings per Share (EPS) is calculated by dividing net income by the weighted average number of outstanding shares. In contrast, diluted EPS includes potential shares that could be created from options, convertible securities, or warrants. This means that diluted EPS provides a more conservative view of earnings as it accounts for the impact of all possible shares that could dilute the ownership interest of existing shareholders.
• What role does Earnings per Share play in evaluating the financial health of companies when comparing common versus preferred stock?
  • Earnings per Share (EPS) primarily applies to common stockholders since it reflects the portion of earnings available to them. For preferred stockholders, dividends are paid before earnings are allocated to common shareholders, so they focus on fixed dividends rather than EPS. This distinction is important as it highlights how common stockholders have residual claims on earnings after all obligations to preferred stockholders are met.
• Evaluate how fluctuations in Earnings per Share can impact investor behavior and market perception during economic downturns.
  • During economic downturns, fluctuations in Earnings per Share (EPS) can lead to heightened investor anxiety as declining profits often signal potential trouble for companies. A significant drop in EPS may cause investors to reassess their valuations and expectations, possibly leading to sell-offs and decreased stock prices. Additionally, poor EPS performance can affect a company's ability to maintain or grow dividends, further driving investors away and reinforcing negative market sentiment.

Related terms

Net Income: The total profit of a company after all expenses, taxes, and costs have been subtracted from total revenue.

Dividends: Payments made by a corporation to its shareholders, usually in the form of cash or additional shares, typically distributed from earnings.

Price-to-Earnings Ratio: A valuation ratio calculated by dividing the current share price by the earnings per share, used to assess a company's relative value.